To Stretch or Not To Stretch – A Real Problem

money flying out of man's wallet

Maybe you have worked all of your life to build a nice IRA to help fund your retirement. In addition, you have set-up an estate plan and trust to make sure your non-spouse loved ones are not just well taken care of, but enjoy the most tax-efficient flexibility possible.

Watch out, congress is trying to tax your IRA sooner vs. later. They are trying to change the rules for “stretch IRA’s”. On May 23, 2019, the US House passed legislation called Setting Every Community Up for Retirement Enhancement Act of 2019, or the SECURE Act.

Example of a Stretch IRA – Current Policy
A person is 70 years old, have a Traditional IRA valued at say $700,000, currently take a RMD (Required Minimum Distribution) and name a 30 year old relative as the beneficiary on their IRA. The RMD and subsequent income for tax purposes is based on their expected remaining life.

Under current tax provisions, if the person passed away today, the 30 year old relative would set-up a new “Inherited IRA” and begin taking RMD based on a life expectancy of 53.3 years (IRS tables). The 1st years distribution will be $13,133 ($700,000/53.3), the relative only pays income on the $13,133!! The Inherited IRA benefits from investments being tax deferred for 53 years, or the RMD is “stretched” over a much longer life span while taking out a much smaller RMD.

Proposed SECURE Act – Changing the RMD to 10 Years
Under the SECURE act Uncle Sam wants to collect their taxes sooner vs later and therefore will require the Inherited IRA to be liquidated in 10 years. Therefore, the annual RMD payment would be $70,000. Now, the relative may like the idea of receiving $70,000 a year, but this will probably toss them into a much higher tax bracket and could cause other unanticipated consequences. The elimination of a “stretch” is a huge disadvantage. Keep in mind that the deceased person probably has an entire estate of other assets that will get transferred to the relative beyond just an IRA. Could your 30-something relative hand this money? 

Eliminating the stretch IRA provisions will have a significant impact on many existing trusts that have been set-up to accommodate IRA retirement plans. Many such trusts allow the trustee to control distributions to the beneficiary based on the timing of RMDs, typically for the life expectancy of the beneficiary. If the SECURE Act is passed, the trustee could be required to distribute the account during the 10-years following the IRA owner’s death, or 10 years following a minor child beneficiary reaching the age of majority, losing the benefit of holding the funds in trust.

Don’t Worry About Your Spouse
The SECURE Act really doesn’t affect your spouse provided your spouse does some pretty simple things. For spouses, not only can they receive distributions based on their life expectancy, they may also “rollover” the inherited IRA into their own IRA, possibly delaying RMDs until the spouse reaches age 70½.

Let’s make sure our law makers don’t get greedy and try to raise our taxes by removing the “stretch IRA” provision!

Caveat: I am not a financial planner and there are many other details to consider in all of these decisions. Please seek help for a tax expert, attorney or certified tax planner before making decisions.